WTI oil drops to 6.5-year low… but where to now?

After falling for nine consecutive weeks, the price of WTI crude hit oil its lowest level since March 2009 on Thursday. Though US oil has bounced off the low ($41.35), it remains near this year’s earlier base of about $42 and thus on course to potentially fall to $40 a barrel next. That being said though, the correction potential is now high as ‘bargain hunters’ try to buy “cheap” oil and the sellers take profit ahead of the weekend. If seen, this would probably only lead to a temporary bounce. After all, the end of the summer driving season is approaching and refineries will have to scale back their operation because of lower demand then and the usual maintenance work. Thus, the almost consistent, but moderate, seasonal destocking that has occurred since early May will likely come to an end soon. As a result, US oil inventories are likely to remain near – or surpass – their current record high levels. As nothing is likely to be done about the supply glut this year, and the expected growth in demand is set to remain weak, oil prices are therefore unlikely to stage a meaningful comeback this year. In fact, the global surplus is expected to increase further as a result of higher Iranian and OPEC output. The supply and demand forces therefore point to lower equilibrium prices. But the markets work based on expectations, so it could be that everything I have just noted is already priced in. There would probably need to be some sort of fresh stimulus to give the sellers confident to commit to their positions at these low levels. So, while still bearish on oil, I am wary of a potential bounce back in the short term from these levels because of the lack of any fresh stimulus and also technical reasons.

WTI’s previous bounce in March from around the $42 area was significant in both nominal and percentage terms, as after all prices did rally from that base by about $20.50 or almost 49%. However, when compared to the sell-off that had occurred in the preceding months that bounce was not too significant after all. In fact, WTI did not even manage to test, let alone break, the shallow 38.2% Fibonacci retracement at $67.00. A shallow retracement (on a relative basis) is usually indicative of further strong continuation moves. As such, if WTI breaks decisively below $42, we may see a continuation to at least the 161.8% Fibonacci exhaustion point of the kick-back rally that had occurred in March, rather than just the 127.2% level. This points to a price level for WTI of just below $30 a barrel, namely $29.35. IF we get there, the probability of price finding a significant bottom there would be very high, but that’s not to say that it won’t fall even further to say $25 or who knows even $20 per barrel.

But as noted, given the technical importance of the $42 handle plus the fact that the RSI is in extremely oversold levels, WTI may stage a short-term bounce towards the upper trend of its bearish channel around $43.70 before deciding on its next move. What’s more, the dollar rally has faded and this could offer an indirect boost for some buck-denominated commodities including crude oil.